(b) Tutorial note: Under exam conditions, candidates would not be expected to replicate the financial table presented in Exhibit 3 within the body of the report which they have been asked to present to the finance director.
It has been included in the answer below for the purpose of demonstrating how a professionally presented report should have been provided to the finance director in a real-life situation.
To: The Chief business analyst
From: Senior business analyst
Date: xx/12/20X8
An evaluation of the proposed acquisition of the Comfi Stay hotel chain
Introduction
The following report presents an evaluation of the proposal to acquire the Comfi Stay hotel chain located in Veelandia. The report will consider the financial viability of the proposal and also consider a range of other criteria upon which to base the final decision and will evaluate the implications of this proposal for HiLite.
From the net present value calculation of the proposed acquisition of the Comfi Stay hotel chain (Table 1), it would appear to be financially viable, returning an NPV of nearly $10·6 million. This equates to a return on the initial investment of 13·2%.
Discounted payback occurs at approximately five years and three months.
However, it would be necessary to assess the viability and reliability of the data contained in the above NPV to assess how realistic the revenue predictions are, based upon predicted customer numbers and revenue per room calculations. Economic conditions may be difficult to predict in a country such as Veelandia and we would need to take a cautious approach in any forecast revenue results.
Likewise, although our initial investment and refurbishment costs may be relatively straightforward to assess, long-term costs in training and operations need to be carefully considered, particularly in the light of the lack of investment which has been carried out in these hotels previously.
We should also consider foreign currency risk exposure, in relation to the stability of the Veelandia currency. We have never operated any hotels overseas and this brings with it a number of challenges for our business in terms of translation and transaction risks.
We have carried out our NPV calculation in our own currency ($), but we must consider the potential impact of the Veelandia currency fluctuations in particular on our forecasted revenues and operating costs.
Before making any decision based upon these financial results, I would like to see possibly a range of NPV calculations based upon best and worst-case scenarios. In addition, before proceeding with the acquisition of the Comfi Stay hotel chain, we should also consider a range of other issues which are set out below:
Strategic fit of the proposed acquisition
We should assess whether the proposed acquisition of Comfi Stay is in line with our strategic position; that is, does it have a strategic fit with the rest of our business? We should also consider the cultural fit with our existing operations, particularly as the Comfi Stay hotel chain is located in a different country, 5,000 miles away.
As the Comfi Stay hotel chain is within our current sphere of business operations as a hotel, it would be considered to have a strategic fit. However, the strength of that strategic fit may be questionable, based on the fact that it is a mid-range hotel chain offering additional facilities such as gyms and pool facilities.
Our current HiLite hotels located in Deeland do not offer such additional facilities and we would need to carefully consider how to integrate Comfi Stay’s hotels into the HiLite brand, which is based upon a ‘budget’ offering. Therefore, strategic fit may not be as clear-cut as we may think.
However, it is evident from the recent Hotel Industry Report for 20X8, that consolidation in the marketplace is becoming common, and hotels operating within different sectors of the market are consolidating through acquisition. Therefore, it would seem that this option could be suitable, based upon recent acquisition activity in the market.
Also, our chief executive has suggested in his Report on Performance for 20X7/20X8 that HiLite is considering the strategic direction of developing the HiLite brand overseas and therefore this would exploit this potential opportunity for us.
Another consideration is the cultural fit of the Comfi Stay hotel chain. As Veelandia is located over 5,000 miles away from Deeland and the fact that the hotels are not budget hotels, there may be cultural differences to consider. The fact that it is a family-run business may also mean that it has a family-based culture which may be difficult to change and integrate into our current operations and style of management.
National culture is also clearly different in Veelandia and may be challenging for HiLite. Poor employment practices and evidence of use of under-age labour in the hotel industry in Veelandia must be thoroughly investigated and we must make sure that our own cultural behaviours are transferred to replace ones which are clearly not suitable for our own operations.
This Environmental Investment 20 must be a priority for HiLite, as our own reputation could be damaged by association with the Comfi Stay hotel chain if we do not address these issues. However, we will also be sensitive to cultural differences and only make changes where necessary.
Acceptability of the acquisition
When considering the acceptability of the proposed acquisition of the Comfi Stay hotel chain, we need to evaluate whether it is consistent with our current objectives in terms of risk and return, and importantly whether it will be acceptable to our stakeholders.
When considering the calculations of net present value, it would be prudent to test the sensitivity of some of our assumptions to evaluate the overall impact of and potential sensitivity of these factors on the final outcome. For example, a failure to achieve the expected occupancy levels from year 3 onwards could reduce the final NPV significantly, as expected revenues would be significantly reduced.
Any combination of variable changes needs to be tested, to assess our sensitivity to potential changes in the underlying assumptions made and the risks which these changes may pose. We must also verify the accuracy of our assumptions.
We also need to consider acceptability of the proposed acquisition to our stakeholders. Our own staff based in Deeland may be largely indifferent to the decision, but those hotel managers who may be requested to re-locate may potentially be reluctant (or conversely may indeed be enthusiastic at the proposal).
We must ensure that this is communicated effectively to these hotel managers in good time, should the decision to acquire Comfi Stay be made. Staff in Veelandia will likely react positively to this investment, if it means that employment will continue and there is likely to be a high possibility of improved employment rights and an improvement in working conditions and opportunities for training.
Our shareholders are likely to be favourable towards the strategy if it creates a positive return on shareholder wealth. The chief executive has clearly stated in his Report on Performance that this is a proposed strategy and therefore shareholders will be accepting of this business development opportunity, as long as it impacts favourably on the profits of the business. However,
we must be mindful of the impact of this decision on our shareholders if they believe this decision may impact adversely on our reputation, as this could indeed impact adversely on shareholder wealth. Effective and regular communication with our shareholders must be carried out.
Customers in Veelandia may not favour this direction for Comfi Stay hotels if it means an increase in prices. However, hotel refurbishments and updates should increase the quality of the hotel offering, which have clearly become outdated due to lack of investment. This improvement to the quality of the Comfi Stay hotels should satisfy potential customers.
We also need to consider how the wider community and the media will react to this decision. There is a risk that it will be seen as unfavourable by the wider public, as Veelandia does not operate to the standards of Deeland and may be seen as being unethical to operate in a low wage economy.
We must make it clear to these stakeholders that it is our intention to operate at the highest ethical standards within Veelandia, should the acquisition be successful. For example, we should follow strict guidelines on offering a fair wage to employees and not allowing under-age workers.
Assessment of resource requirement of the proposed acquisition
We must also consider whether we have the resources we need to carry out the acquisition of the Comfi Stay hotel chain. It would appear that we have the necessary funds available to undertake the strategy, through a combination of debt and equity.
We are a highly profitable business and shareholders will be expecting us to continue the growth in profit which we have achieved in recent years. Therefore, shareholders should be supportive of such an investment through equity and debt finance.
We also need to consider our core competences and our strategic capabilities required to undertake this acquisition. We have never undertaken an acquisition strategy before, therefore we must assess our own management skills and capabilities to undertake this strategy successfully.
Without the necessary expertise, we could make a number of errors in the process of acquisition, resulting in its failure. We may need to consider hiring external consultants to assist with the acquisition process.
We must also assess our skills and competences to operate and manage these hotels in Veeladia. We have highly skilled staff who can be used to train and work with the Comfi Stay hotel staff to ensure that we manage the transition carefully and successfully.
However, it is likely that local staff will not have the same level of training, commitment and loyalty which will need to be developed if the venture is to succeed. This may be a large barrier to overcome. However, the planned investment in training local staff is significant and therefore this should go a long way to ensuring that the proposed acquisition is successful.
However, on-going management and monitoring of local staff and management will be critical.
Concluding comments
There are a number of positive factors to suggest that the acquisition of Comfi Stay hotel chain is a viable strategy for HiLite.
However, the board of directors should prioritise which aspects of the decision criteria are most important to the success of the venture before making a final decision.
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